Rosy Kumar: Making the distinction

CAVEAT EMPTOR

SHOULD A company director be asked to pay back investors from his or her personal funds? And can directors be jailed if their companies fail to return money to investors or depositors?

At first glance it might seem like an equitable principle that a company director should suffer for the faults of his company. But that's not how the legal system works.

Let's step back to 1897 and one of the core cases in corporate law. In Salomon vs Salomon it was laid down that an incorporated company is an entity distinct from the individual shareholders and that the business carried on by the company belongs to it.

A director or even the managing director of the company cannot be held responsible for the discharge of liabilities incurred by the company.

The principles laid down in Salomon vs Salomon are accepted around the world. Indian courts have always accepted them as settled legal points.

But there have been challenges over the years and the civil courts, the consumer courts and the Company Law Board are constantly hearing cases in which people apply to have directors jailed or for them to make payments from their personal funds. Directors are included as defendants in these cases.

What's more surprising is that the courts frequently rule that action should be taken against company directors and quite a few have been directed to discharge the liabilities of the companies.

In 1998 a Delhi district forum went to the extent of sentencing Rajendra Prasad Mittal and Rakesh Kumar, the directors of Triputi Builders, to one year's imprisonment in some cases and six months in some others in each of 344 complaints.

The court further directed the sentence to run consecutively and not concurrently, meaning that in all they were to undergo imprisonment for 182 years. Their fault was that their company had failed to refund the amounts taken from the complainants.

Recently, the Tamil Nadu State Consumer Disputes Redressal Commission dealt with the question of director's liability for the non-payment of dues by the company. The facts were that EBF Finance, incorporated under the Companies Act, 1956 had taken deposits from the public and fixed deposit receipts were duly issued.

The company failed to honour its commitment and could not pay back depositors. The aggrieved depositors approached the District Consumer Disputes Redressal Forum, Madurai, asking for repayment. The company's directors were also made parties to the proceedings.

The directors pleaded that they were non-executive directors with no role in the company's day-to-day working, and were in no way liable. But the district forum did not agree with this contention and passed orders against them as well as the company and they were all directed to make payments.

The directors filed an appeal against the order before the Tamil Nadu State Commission. In its order dated January 6, 2004 in the matter of S V Shanmughavadivelu and others vs T Renganathan and another, the commission held that a company constituted under the Companies Act is a juristic person and a separate entity distinct from its shareholders and the directors.

Therefore, the business carried on by the company belongs to it in the capacity of its legal entity and the directors or for that matter even the managing director of the company cannot be proceeded against for realisation of money due.

The court further held that there is no personal obligation of the directors or shareholders in respect of "the debts or even taxes, revenue due from the company and that there is no statutory provision in the Consumer Protection Act which entitles either a creditor or even the Government to proceed against the director of a limited liability company and that it is only the assets of the company that can be proceeded against."

The above decision lays down the correct legal position on directors' liability regarding the company's debts. Therefore it can be safely stated that action cannot be maintained against the directors of companies. So, the only solution for investors is that they should be very cautious about making any investments.